Open for business: why China’s NOCs are looking West for inspiration

3 February 2015 (Last Updated September 22nd, 2020 14:41)

China has put a record number of offshore blocks up for auction as it looks to kick-start its domestic oil and gas industry through joint ventures with foreign operators. Julian Turner asks Joseph Gatdula, GlobalData’s senior upstream analyst covering Asia-Pacific and the former Soviet Union, for his views and examines whether the latest licensing round could signal a new era of international cooperation.

Open for business: why China’s NOCs are looking West for inspiration

Liwan field

With its shale gas plans stalled and domestic demand for oil outstripping output by 0.9% annually, China National Offshore Oil Corp (CNOOC) invited international oil companies (IOCs) to bid for an unprecedented 33 offshore blocks in September as part of its annual oil and gas licensing round.

To analysts, this was the clearest sign yet that the Chinese Government under Xi Jinping intends to reduce its reliance on imports from the Middle East - and the resulting exposure to fluctuations in global oil prices - and instead enter into joint ventures (JVs) with foreign companies to exploit the 24.4bn barrels of proven oil reserves located in the Songliao, Ordos, Bohai Bay and Jungar basins.

China has made it a priority to extract unconventional oil and boost flagging production from these fields. In the first half of 2014, production from the Bohai Bay, which accounts for more than half of all Chinese crude, declined 2.5% from last year to 411,000 barrels of oil equivalent per day (boepd).

"In March 2014, China replaced the US as the world’s largest net importer of oil and will likely require 600 million tons of crude by 2020."

"The invitation for bids for 33 exploration blocks will be a boon for both domestic and foreign companies," states Joseph Gatdula, GlobalData's senior upstream analyst covering Asia-Pacific and the former Soviet Union. "Domestic firms will continue to enhance their offshore experience and capabilities, while IOCs will gain a foothold in the second largest consumption market of energy.

"This latest bid is a reflection of China's desire to increase not only domestic production, securing future energy supplies, but also to develop its own domestic oil and gas industry through the knowledge transfer that IOC participation will bring."

Unconventional profits: the race to exploit China's tight oil reserves

In March 2014, China replaced the US as the world's largest net importer of oil and will likely require 600 million tons of crude by 2020. Lacking the requisite infrastructure and expertise to meet the energy demands of its 1.35bn people, the Chinese authorities have no choice but to import these essential skills as well.

For Western firms well-versed in enhanced oil recovery techniques, the potential rewards are huge. Horizontal drilling and hydraulic fracturing will not only maximise production from existing basins; they could be invaluable when it comes to exploiting China's vast reserves of tight oil - light crude trapped in low-porous shale, limestone and sandstone formations - estimated at 78 billion barrels.

"Multiple IOCs are currently operating in the Chinese offshore waters," confirms Gatdula. "Currently, GlobalData's new analytics platform shows 18 IOCs participating in 59 different offshore fields at a combined output of almost 500,000 boepd."

CNOOC has already signed agreements with Smart Oil Investment and Italy's Eni SpA to cooperate on offshore domestic blocks, while Xinjiang HTDT, a newly formed oil service JV between US giant Halliburton and China's SPT Energy could provide the blueprint for future collaborations between local firms and global oil field service companies with high-end drilling technology and experience.

"SPT has 20 years experience operating in Xinjiang, while Halliburton would contribute its expertise in enhancing oil recovery using fracturing technology," said SPT CFO Sun Xiaogang. "Among the geographically complicated regions in China, Xinjiang is rich in tight oil and tight gas resources."

The deal will see SPT hold 51% of the new entity and Halliburton 49% (according to the Wall Street Journal, foreign companies typically pay all exploration and development costs in China and can't own more than 49% of a project) and follows hot on the heels of a landmark 15-year JV signed in June involving US fracking specialist FTS International and China's state-owned Sinopec.

"The invitation for bids for 33 exploration blocks will be a boon for both domestic and foreign companies."

The first oil field services collaboration of its kind between a non-Chinese well completion company and a Chinese national oil company, the deal will focus on the Sichuan basin, China's most promising shale play. The previous month, Weatherford International and Sinopec Group signed a similar JV aimed at expanding the Chinese company's upstream business. The deal will develop the estimated 145 trillion cubic metres of recoverable shale gas resources in the Sichuan and Tarim basins.

Risks vs rewards: will foreign companies take the plunge in China?

So, does the Chinese Government's decision to place a record 33 blocks off the coast of China up for auction herald a new era of international cooperation for the oil and gas industry? Yes and no.

Foreign investors continue to adopt a conservative stance over China due to high development costs (CNOOC has offered deepwater blocks in recent years, but these wells can cost more than $1 billion to drill), multiple political, operational and regulatory factors - not least the influence exerted by the nation's national oil companies (NOCs) - and a lack of information on the quality of energy assets. Major differences exist in the technological understanding and geological structures of China and the US's tight oil, making it difficult for China to replicate US success in unconventional development.

A GlobalData report, 'Tight oil in China offers an alternative to delayed shale gas development', notes that, unlike tight oil formations in North America, Chinese reserves are characterised by heterogeneous rock types and physical features, as well as varying oil properties and saturations. The formations are rich in hydrocarbon content, but it is thick and is distributed among small, locally formed areas. Exploratory drilling has also shown that the oil production has a high decline rate.

Political ideology has also contributed to the relatively slow growth of China's oil and gas sector. Many of the fields encroach on hotly contested maritime borders, an issue that made global headlines in May when CNOOC deployed the drilling rig HD-981 to an area 120 miles off the coast of Vietnam. The Vietnamese Government said the decision to enter disputed waters violated its sovereignty, while the US accused Beijing of 'provocative' behaviour as part of an ongoing land grab in the South China Sea. China's drive to develop its domestic hydrocarbon industry may also change the subtle dynamics of its relationship with Malaysia, the number one producer of petroleum in the region.

Finally, regulatory support for tight oil exploration in China is still in the academic and scientific stage - research projects form part of Program 973, known as the National Basic Research Programme - and may pose a barrier to production unless concrete policies and financial support are announced.

Proceed with caution: the future of China's oil and gas industry

As the Chinese economy changes from one driven primarily by investments and exports toward one characterised by greater domestic consumption, so the demand for reliable energy will increase.

"A newly formed joint venture between US giant Halliburton and China’s SPT Energy could provide the blueprint for future collaborations between local firms and global oil field service companies."

In the short term, foreign companies continue to tread carefully in China, investing in more mature, low-risk fields with guaranteed revenue streams - CNOOC offered 25 blocks to foreign firms in 2013, but no successful bids were revealed - while closely monitoring the Chinese Government's efforts to revitalise its domestic oil and gas industry as well as its aggressive oil acquisition programme abroad.

CNOOC recently announced its first independent deepwater gas discovery, Lingshui 17-2 in the Qiongdongnan Basin, while a total of 26 new tight oil wells were planned in Qinghai oil field in 2014. China's first large-scale deepwater gas project at Liwan, a partnership between CNOOC and Canada's Husky Energy, came online in late 2013 and other IOCs, namely Chevron, BG, BP and Anadarko, have all signed production-sharing contracts for deepwater hydrocarbon blocks in the South China Sea.

"China will continue to develop its oil and gas expertise through domestic efforts, such as this bid round, as well as continuing to acquire fields and companies internationally," confirms GlobalData's Josepth Gatdula. "The most competitive block bids should come from the largest producing areas - Bohai Gulf, Beibu Gulf and the South China Sea - as the existing infrastructure and knowledge will reduce the exploration risks and the time to bring commercial assets to market."

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